Securities Regulation

03/18/2019

Managers likely will see developments in the Securities and Exchange Commission’s work in this area “around the end of proxy season this year,” said Dalia Blass, director of the agency’s Division of Investment Management. She was speaking at the Investment Company Institute’s Mutual Funds and Investment Management Conference in San Diego.

The agency is looking at how to promote voting practices that are in the best interest of managers’ clients and whether they should vote all proxies, Blass said. The commission also is examining how managers should handle possible proxy advisory firm conflicts of interest and evaluate the advisers’ recommendations, especially when companies disagree with the advice, she said. Proxy firms include Glass, Lewis & Co., in addition to Institutional Shareholder Services Inc.

In arguing that institutional investors have incentives to be rationally apathetic, we emphasized the costs entailed in monitoring and responding to problems at portfolio companies. These costs could be reduced if activist investors could make use of economies of scale by developing standardized voting procedures on recurring issues and standard responses to common types of managerial derelictions. We in fact observed just such a response very early in the evolution of institutional investor activism as many institutions adopted standard voting practices on issues such as takeover defenses.

Significant savings, however, would require collective action. Only by clubbing together in monitoring their portfolio companies, could institutions truly achieve economies of scale. As long as they were obliged to act individually, the size and high rate of turnover of their portfolios made achieving real economies of scale impractical.

The emergence of Institutional Shareholder Services (ISS) offered a solution to these problems. ISS was founded in 1985 to provide proxy advisory services to institutional investors.[1]The premise was that institutions could outsource to ISS the tasks of monitoring corporate governance at portfolio firms and making decisions about how to vote their shares.

ISS got a major boost in 1988 when the Department of Labor announced that ERISA pension plan fiduciaries had a fiduciary duty to make informed decisions about how they voted shares of portfolio companies. In response, pension plans began to rely on ISS for analysis of issues upon which a shareholder vote would be required and advice as to the best voting decision. A similar 2003 SEC ruling that mutual funds and other investment company advisors must adopt policies designed to ensure that shares of portfolio companies are voted in the best interests of their clients added a whole new class of institutions that outsourced their proxy decision making to ISS.

Today, ISS services some 1700 institutional investor clients, which collectively manage some $25 trillion in equity securities. The goal of reducing the expenses of activism through economies of scale thus seems well within reach.

ISS has proven highly successful at influencing shareholder voting. By some estimates, an ISS recommendation can effect a swing of 15 to 20% in a proxy vote.[2]Although competitors have entered the market for proxy advisory services, ISS remains the most powerful player in that market. Only one other advisory service, Glass, Lewis & Co., has a measurable effect on the outcome of shareholder votes and its impact remains minor compared to that of ISS.[3]

The shareholder empowerment provisions of Dodd-Frank are widely expected to further enhance ISS’s influence, especially with respect to executive compensation. Institutional investors will look to ISS for guidance on both the say when on pay and say on pay votes. The biggest effect of Dodd-Frank on proxy advisory services, however, is likely to come indirectly via NYSE Rule 452.

The NYSE rule deals with voting of shares held in brokerage accounts. The typical retail investor account is set up with the broker as the legal owner of the shares and the investor as the beneficial owner thereof. Under state law, the brokers therefore are the ones who vote the shares. Under federal law, brokers are obliged to request voting instructions from their client. Many retail investors, however, fail to provide instructions. In such cases, Rule 452 permits the broker to vote the shares in its discretion with respect to routine matters. As to non-routine matters, however, a broker without instructions must abstain.

In the past, brokers routinely voted as management recommended. As a result, management often had a substantial base of support on many issues. A 2009 amendment to Rule 452 significantly altered the environment, however, by changing the treatment of an uncontested director election from a routine to a non-routine matter. As a result, the number of retail investor-owned shares voted in director elections has fallen, increasing the proportion of institutional investor votes as a percentage of those being cast, and thereby enhancing the effect of an ISS recommendation.

Dodd-Frank § 957 will have a similar effect in a potentially wide range of issues. At a minimum, § 957 requires that votes on executive compensation be deemed non-routine. The proportion of votes coming from institutional investors therefore will rise with respect to both say on pay and say when on pay decisions. Because § 957 directs the SEC to undertake a rulemaking proceeding to determine whether there are “other significant matters” that should be deemed non-routine, which proceeding is expected to be completed by late 2012, ISS’ influence likely will continue to grow. Indeed, it seems fair to say that Dodd-Frank does more to empower ISS than it does shareholders.

Despite its success (or, perhaps, because of it), ISS has been controversial. Some critics argue that ISS is too rigid and mechanical in its advice. Martin Lipton complains, for example, that ISS routinely recommends against reelection of a board’s nominating committee if those members allow the firm’s CEO to provide recommendations or advice:

It would be a totally dysfunctional process if input and advice from the CEO were prohibited until after the committee meets and makes its decisions. There is nothing in the NYSE rule or “best practices” that warrants restricting the CEO from voicing advice or opinion until after the committee has acted. [4]

A related example of excessive rigidity on these issues came in 2004, when ISS urged its clients to oppose reelecting Warren Buffett as a director of Coca-Cola because Buffett did not satisfy ISS’ strict definition of director independence. Shortly thereafter, CalPERS announced that it would oppose Buffett’s reelection on the same grounds. Critics of the ISS and CalPERS positions pointed out that Warren Buffett is probably the most respected investor of all time, with a long record of integrity. At the time in question, Buffet’s Berkshire Hathaway Company owned almost 10% of Coke’s stock, which meant that his personal financial interests were closely aligned with those of other shareholders (albeit not perfectly). Buffett qualified as an independent director under the NYSE’s listing standards. As I argued at the time, if “Buffett doesn’t qualify as independent under the ISS and CalPERS standards, the problem is with the standards not Mr. Buffett.”[5]

Critics link this sort of check the box mentality back to the very reason for outfits like ISS to exist; namely, the cost associated with making informed voting decisions about numerous issues posed on the proxy statements of the thousands of publicly traded companies. The globalization of institutional investor holdings has compounded the problem by forcing ISS to stretch its resources to include many foreign issuers. In 2009, for example, ISS had to prepare voting recommendations with respect to more than 37,000 issuers around the world. The constantly growing number of voting recommendations that must be made, most of which are concentrated into the three to four month annual meeting season, reportedly forces even ISS to automate decision making to the fullest possible extent and, accordingly, to rely one one-size-fits-all standards instead of giving careful consideration to the specific needs and circumstances of each individual firm.

Finally, there is the question of accountability. Although both the SEC and the Department of Labor are considering regulation of the proxy advisory business, as of this writing they remain essentially unregulated. Ironically, market forces are the only thing holding ISS accountable; i.e., the same forces most shareholder power proponents claim do not work when it comes to holding management accountable.

Taken together, these concerns raise serious issues as to whether shareholder activism is an appropriate solution to the principal-agent problems of corporate governance. The view that institutional investor activists will carefully scrutinize portfolio companies to reach informed voting decisions is exposed as a fiction. Instead, shareholder activism depends on the whims of a single proxy advisor who offers limited transparency and is largely unaccountable, essentially unregulated, and poorly informed.[6]

03/08/2019

Kosmas Papadopoulos reports on early 2019 trends in shareholder proposals. As usual, left wing activists (including some who run funds that are supposed to be profit maximizing) are submitting reams of environmental and social proposals. One caught my eye:

The increasing costs of medication in the U.S. have raised concerns amongst consumers, politicians, and some shareholder proponents over many years, and the issue has been the focus of public debate and political discourse. In previous years, shareholder proposals seeking reporting and oversight on drug price increases either received low support levels (with median support of approximately 5 percent of votes cast) or received no-action letters by the SEC and were omitted from ballots. Shareholder proponents took a new approach in 2018, whereby five proposals asked companies to report on how they integrate risks related to public concerns about drug pricing in their executive compensation programs. The five 2018 proposals received a healthy median support level of 23 percent of votes cast, and proponents have filed at least nine such proposals so far in 2019.

Basically these so-called "investors" want the companies in which they typically have trivial investments to cut prices, reducing profits, and lowering all shareholders' returns. Why do we put up with this nonsense?

The basic problem is that the SEC and the courts have gutted the exemption under Rule 14a-8(i)(7) that allows exclusion of proposals that relate to ordinary business.

Is there a more ordinary business decision than deciding what price to charge for your goods?

And this new tactic of asking for a "report on how they integrate risks related to public concerns about drug pricing in their executive compensation programs" ought to be a nonstarter. As the Third Circuit made clear in Trinity Wall Street, proposal drafters are not allowed "to evade Rule 14a–8(i)(7)’s reach by styling their proposals as requesting board oversight or review.” Trinity Wall St. v. Wal-Mart Stores, Inc., 792 F.3d 323, 344 (3rd Cir.), cert. dismissed, 136 S. Ct. 499 (2015).

For more on the underlying problem and a proposed solution see my article Revitalizing SEC Rule 14a-8's Ordinary Business Exemption: Preventing Shareholder Micromanagement by Proposal (March 29, 2016). Available at SSRN: https://ssrn.com/abstract=2750153

These identical bills would require public companies to disclose “Data, based on voluntary self-identification, on the racial, ethnic, and gender composition of the board of directors of the issuer; nominees for the board of directors of the issuer; and the executive officers of the issuer.” The bills would also require disclosure of veteran status, and any policies for promoting diversity among boards of directors and corporate executive officers. And then, oddly, the bills would require the Commission’s Director of the Office of Minority and Women Inclusion to publish “best practices with respect to compliance with this subsection,” in consultation with a newly established advisory council of issuers and investors (I say “oddly” because – they want to publish best practices for disclosing diversity information? I’m guessing that’s not what they’re going for, but that’s how it’s drafted.)

In any event, these bills represent something of a challenge to the efficient markets hypothesis because in most (if not all) cases, the racial, gender, etc characteristics of board members, board nominees, and top officers is readily available to investors. What may not be available, of course, are policies for promoting diversity, absent a rule requiring disclosure – which it turns out, we already have, at least with respect to director nominations. See 17 CFR § 229.407(c)(2)(vi); see alsoDevelopments on Public Company Disclosures Regarding Board and Executive Diversity.

Of course, the reality is these “disclosure” rules are not about disclosure at all; they’re about substantively pressuring companies to diversify their management teams – which explains, I assume, the bit about “best practices”; the goal is to craft guidelines for best practices in hiring, not best practices in disclosure.

I am not a fan of the existing diversity disclosure rule, but let's set that aside for a minute. Note that the proposal requires disclosure of diversity status based on "voluntary self-identification." So if I suddenly announce that I self-identify as a gay disabled Afro-Cuban female veteran is that what the company will report? I realize that the prevailing politically correct viewpoint is that identity is fluid and a social construct (or whatever) but I'm not sure the securities laws are an ideal place for it.

02/22/2019

After the financial crisis and the recent insider trading convictions of Raj Rajaratnam and Rajat Gupta, perhaps it is time to reconsider the plight of Jeffrey K. Skilling.... The problem is that the case against the Enron executive was...

Back in January, Gordon Smith said he "would not be surprised to see both Ken Lay and JeffSkilling acquitted, but perhaps the government's case is stronger than I expect." Now Gordon says: "The government's case was pretty much what...

Regular readers will recall that we have been folllowing the misadventures of Andrew Fastow, former CFO at Enron, and his wife Lea. Andrew had agreed to coperate with the feds investigating JeffSkilling and Ken Lay, provided his wife go...

Part of the Enron mythology is that former Enron VP Sherron Watkins blew the whistle on Ken Lay, JeffSkilling, and their fellow miscreants. In fact, however, so-called “Enron whistle-blower” Sherron Watkins never really blew a whistle. ...

02/09/2019

New York City Comptroller Scott Stringer, in a Feb. 7 letter obtained by Bloomberg Law, called for the investigation into what he says are “dramatically” contrasting stories about Oracle’s pay practices. The Labor Department has alleged in an ongoing lawsuit that the software maker systematically shorted women and minorities $400 million in wages.

Oracle’s board painted a different pay picture when it recently tried to quash a shareholder proposal seeking disclosures on any gender-based pay gaps at the company, Stringer wrote. The board told investors to vote against the proposal at its most recent annual meeting, citing Oracle’s commitment to avoiding gender pay gaps.

Stringer called the board’s statement “a model of self-promotion, avoidance, and evasion.” New York City’s pension funds, which hold about 6 million Oracle shares, supported the pay gap proposal.

This prompted Ann Lipton to tweet:

So as I understand it, Scott Stringer is alleging Oracle committed securities fraud in its management recommendation against a shareholder proposal, is that right? Been waiting for something like this but I don't remember seeing it before. https://t.co/mkOKUzCqER

There aren't a ton of cases but there have been a few. United Paperworkers Intern. Union v. Intl. Paper Co., 985 F.2d 1190, 1198 (2d Cir. 1993), is especially interesting because it held that any shareholder (not just the proponent) could bring a 14a-9 suit where management's response to a shareholder proposal put forward under Rule 14a-8 was fraudulent.

Labor unions that held stock in Stevens alleged Stevens had committed numerous violations of the federal proxy rules, the most pertinent of which for present purposes alleged "proxy rule violations in statements made by Stevens in response to shareholder proposals submitted at the 1976, 1977 and 1978 annual meetings."

The 1976 shareholder proposal recommended that the Stevens Board appoint a committee of outside directors to study and report to shareholders on the costs of Stevens' then current labor disputes. The 1977 proposal requested the Board to report to shareholders on Stevens' labor policies and practices. Three 1978 proposals requested a Board report to shareholders on the company's labor policies and practices, the impact of the company's labor-management policies on the economic performance of the company's stock, and on employee occupational safety and health. A fourth 1978 proposal asked the Board to establish a review committee to advise on management-employee relations. Each of these proposals was overwhelmingly defeated. The complaint alleges that management's statements addressed to these proposals were misleading essentially for failure to include the same kinds of information which plaintiffs contend should have been included in the proxy statements.

The court explained:

Section 14(a) of the 1934 Act prohibits solicitation of proxies “in contravention of such rules and regulations as the Commission may prescribe . . . .” Rule 14a-9 prohibits solicitation by means of a proxy statement which contains “any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading. . . . ” ...

Plaintiffs contend that the proxy rule requires in connection with the election of directors the disclosure of Stevens' alleged corporate policy to “thwart”, “resist”, and “abuse” the federal labor laws as well as alleged expenses (primarily legal fees) resulting from such policies. Plaintiffs do not dispute that Stevens has disclosed the various labor litigation in which it has been involved and the specific findings of labor law violations. Rather, disclosure is sought of the corporate policy to thwart the labor laws in substance the aims and intentions of the Stevens board with respect to a body of law.

The court rejected plaintiff's claims, inter alia, because "the proxy rules simply do not require management to accuse itself of antisocial or illegal policies."

As to management's responses to the shareholder proposals, once again management is not required to accuse itself of evil or illegal intentions. Plaintiffs' claim here is somewhat stronger because management did make self-serving declarations in response to the proposals, including statements that “it is not and never has been (Stevens') policy to violate (the) law”; that Stevens has “a total commitment to conduct (its) affairs completely within the law”; that “the Company has offered contract terms (to its employees) believed to be fair and reasonable”; and that “the Company costs . . . attributable to the union organizing and related activities are not material in the Company's overall operation.”

If management had undertaken in its responses to recite facts establishing its innocence, such recitation might well give rise to an obligation to disclose any additional facts needed to put the statements made in perspective or prevent them from being misleading. But the assertions complained of here amount to nothing more than protestations of innocence of mind. They do not give rise to an unrealistic obligation to declare guilt.

In my view, allegations of "self-promotion, avoidance, and evasion" likewise "do not give rise to an unrealistic obligation to declare guilt."

01/22/2019

Defendants are hoping that the Supreme Court’s decision earlier this month to grant certiorari in Varjabedian v. Emulex Corp.[11] will produce a decision that slows the spread of merger objection cases. In that case, the Ninth Circuit panel held that because Section 14(e) of the Securities Exchange Act authorizes the SEC to prohibit acts not themselves fraudulent under the common law or Section 10(b) (at least if the prohibition was reasonably designed to prevent acts and practices that were fraudulent), the plaintiff in such a case need not allege scienter, but only negligence. Although this position is arguable, every other circuit that has ruled has decided to the contrary, and the Ninth Circuit has not done well in the Supreme Court when it is the lone dissenter among the circuits. More importantly, some hope that the Supreme Court will rule (as some amici have requested it to do) that there is no implied private cause of action under Section 14(e). Although this is possible, the issue was not discussed in any detail in Emulex. Thus, the court is more likely to insist on scienter, while noting in a parenthesis or footnote that “for purposes of this case we have assumed with the parties that a private cause of action exists under Section 14(e), which issue we reserve for a future day.”

Still, assume that the court either says that there is no private cause of action under Section 14(e) or mandates that scienter must be plead. What will the impact be? Either decision will, of course, provoke hundreds of law firm memos to clients, but the real world impact may be very modest. Plaintiffs could simply assert the same allegations under Section 10(b) and Rule 10b-5. Or, if a merger vote by a publicly listed corporation is involved, a cause of action might also be plead under the proxy rules and Section 14(a) (and such a suit in some circuits requires no allegation of scienter). The false premise in expecting Emulex to restrict the flood of merger objection cases is the assumption that plaintiffs want to take their cause of action to trial. In the vast majority of such cases, however, they do not. Rather, they are either (a) exploiting the lawsuit’s potential ability to disrupt the merger’s timetable or (b) selling preclusion to the defendant because settling the current frivolous suit may prevent other litigation with greater merit. Hence, the fact that plaintiffs must base their cause of action on Rule 10b-5 (where they cannot satisfy the pleading requirements) is not prohibitive because they plan to settle, not fight.

First, judges could solve that problem by smacking plaintiff lawyers who bring such cases with Rule 11 sanctions. But most federal judges lack the spine to do so. Second, somebody like Ted Frank or Sean Griffith could intervene in such settlements.

Update:

I think you’re right now that I stop and think about it. Section 14(e) lacks the purchase or sale requirement, which allows for standing for non-tendering shareholders. See Piper v. Chris-Craft, 430 US 1, 39.

As a followup to my previous post, I should note that some have argued that the case presents the Supreme Court with a broader issue than the scienter question on which my Legal Pulse column focused. Ann Lipton, for example, points out that:

Whether the Ninth Circuit correctly held, in express disagreement with five other courts of appeals, that Section 14(e) of the Securities Exchange Act of 1934 supports an inferred private right of action based on a negligent misstatement or omission made in connection with a tender offer.

So what the defendants are really angling for is a declaration that plaintiffs cannot bring claims under 14(e) at all, with a fallback position of, if they can, they have to show intent.

Ann points out that tossing the private right of action under Section 14(e) and Rule 14e-3 would lead to all sorts of odd results when you step back and look at how Delaware corporate and federal securities law interact in this context. (Go read it.)

As Ann points out, the modern Supreme Court is a lot less found of implied private right of action than it used to be, but as she also points out the Court is reluctant to outright overturn long established implied private actions. As I tell my students, the Court has gotten out of the business of creating or expanding implied private rights of action, but has grandfathered those that have been approved at some point by a one of at least 5 justices. If so, the section 14(e) implied right of action is safe.

Chamber’s counsel argued in its amicus brief that the courts of appeals have ignored the U.S. Supreme Court’s precedents on inferring statutory rights of action. The Chamber’s brief, in urging the Court to take up the case, contended that the case could provide the Court a chance to rule that the circuit courts improperly implied a right of action under Section 14(e) and could thereby eliminate a “complex, judicially-created liability scheme.”

In her November 14, 2018 post on her On the Case blog about the Chamber’s amicusbrief (here), Alison Frankel quotes Stanford Law Professor Joseph Grundfest as predicting not only that the Court would take up the Emulex case, but that it would conclude that there is no private right to sue under Section 14. Interestingly, in making his comments, Grundfest does not seem to be limiting his prediction just to the private right of action under Section 14(e); rather he seems to be suggesting that the Court will conclude there is no private right of action at all under any part of Section 14. Obviously, if the Court were to go so far, then the Emulex decision would indeed have a very significant impact on federal court merger objection litigation.

There may be grounds to be skeptical of the likelihood that the Court would in fact go so far as to eliminate the private right of action under Section 14 altogether, or even with respect just to Section 14(e). In her article about the Chamber’s amicus brief, Frankel quotes counsel for Emulex as saying, first, that Congress has amended the securities laws numerous times since the courts recognized the private right of action under Section 14(e), and yet did not address the issue. In addition, Emulex’s counsel notes that the issue of whether there is a private right of action under Section 14 arguably was not fully addressed in the courts below, which would seem to eliminate the possibility that the Supreme Court would take up the issue for the first time in the case now. Indeed, the plaintiff in the Emulex case argued in his brief in opposition to the cert petition (here) that Emulex itself conceded in the lower courts that there is a private right of action under Section 14(e).

... some have seen the case as an opportunity for the high court to go far beyond that question and deny investors any ability to bring claims under Section 14(e), declaring that no private right of action exists, regardless of the standard.

This effort is misguided for several reasons. First, the Emulex case is a poor vehicle to consider a question of this magnitude, especially after petitioners raised the issue only as a passing afterthought in the petition itself, and never briefed it below. Second, the question is not ripe for the Supreme Court’s review, given that there is no circuit split on this issue, despite private Section 14(e) claims having been recognized for decades. Third, even if the court were to take up this broader question, the court’s own reasoning in past Section 14(e) cases supports the existence of an implied private right of action. And finally, as a policy matter, while state court remedies provide some means of relief for investors defrauded in the context of a merger, federal courts should not abdicate their role in protecting investors and ensuring the integrity and transparency of tender offers.

They go on to elaborate on each of those points in some detail, concluding:

A case in which the issue was not even raised below, and where there is no circuit split, is hardly the correct vehicle to consider eradicating a long-recognized federal right.

All of which seems correct. As Ann Lipton points out, however:

... the Supreme Court doesn’t have to go all the way to holding that 14(e) provides no right of action to make an impact; all it has to do is say “We reserve for another day the question whether a private right of action exists under 14(e),” and we are off to the races. Expect a bunch of test cases, and a concerted, coordinated build of precedent in the lower courts, now more populated with Republican judges inclined to be skeptical of private claims. And that, I suspect, is really what the defendants, and the Chamber of Commerce, consider endgame.

01/09/2019

Adding to mounting conservative criticism of a Securities and Exchange Commission rule that prohibits people who settle with the commission from thereafter denying the government’s allegations, the libertarian Cato Institute sued the SEC Wednesday in federal court in Washington, D.C., alleging that the SEC’s "gag rule" is unconstitutional.

“The government uses its extraordinary leverage in civil litigation to extract from settling defendants a promise to never tell their side of the story, no matter how outrageous the government’s conduct may have been and no matter how strong the public’s interest may be in knowing how the government conducts itself in high-stakes civil litigation,” the Cato suit said. “This civil-rights lawsuit seeks to end the federal government’s decades-long use of gag orders in violation of the First Amendment to the United States Constitution.”

One of the strongest rules in free-speech law is that the government may not engage in “prior restraint” of speech except in extreme circumstances. Yet the Securities and Exchange Commission does so routinely. Under a rule adopted in 1972, the SEC demands that parties entering into settlements with the commission be silenced about the prosecution forever. If they question the merits of the case against them, the SEC reserves the authority to reopen it. ...

The SEC’s gag rule is a symptom of a broader problem: Administrative agency power tends to expand beyond its lawful scope. This is why the Founders were so obsessively concerned that the three branches of government operate publicly subject to carefully constructed checks and balances.

In October, the New Civil Liberties Alliance filed a petition asking the SEC "to amend its rule restricting speech that is set forth in 17 C.F.R. § 202.5(e) (“The Gag Rule”). ... The Rule is unconstitutional, without legal authority, and further is ill-conceived policy."

01/03/2019

An increasing percentage of corporations are going public with dual class stock in which the shares owned by the founders or other corporate insiders have greater voting rights than the shares sold to public investors. Some commentators have criticized the dual class structure as unfair to public investors by reducing the accountability of insiders; others have defended the value of dual class in encouraging innovation by providing founders with insulation from market pressure that enables them to pursue their idiosyncratic vision.

The debate over whether dual class structures increase or decrease corporate value is, to date, unresolved. Empirical studies have failed to provide conclusive evidence as to the effect of dual class structures, and calls for regulators or stock exchanges adopt prohibitions banning dual class structures outright have been unsuccessful, although several index providers have banned dual class stock from major indexes such as the S&P 500.

As a result, some commentators have advocated a compromise position permitting corporations to go public with dual class structures but requiring that they be required to include mandatory time-based sunset provisions. The sunset provisions would automatically convert the dual class structure to a single share structure after the passage of a pre-determined period of time. The Council of Institutional Investors has asked the New York Stock Exchange and Nasdaq to refuse to list the shares of dual class firms unless they contain a time-based sunset provision that would convert within seven years.

We do not take a position on whether dual class structures are value-enhancing, but we challenge the proposition that time-based sunsets are an appropriate response to the debate over dual class and that they should be imposed through regulation or stock exchange rules. To the extent that dual class structures are problematic, sunsets do not solve that problem. Moreover, time-based sunsets are an arbitrary response to the concern that developments such as the decline in a founder’s economic interest or the transfer of high-vote shares to third parties may reduce the attractiveness of the dual class structure. In addition, time-based sunsets create potential moral hazard problems. We further argue that the limitations of time-based sunsets cannot be addressed through a retention vote by the minority shareholders due to the problematic incentives of the minority shareholders.

We observe that event-based sunsets, which have received less attention, focus on the specific developments that are likely to erode the potential value of dual class, and we call for market participants to explore them further through private ordering. Nonetheless, we argue that, at the present time, investors and policymakers lack sufficient information about either dual class or sunsets to justify using regulation, index requirements or stock exchange rules to force companies into adopting sunsets. We further argue that, rather than relying compulsory sunsets to evade the difficult policy issues raised by dual class, the debate should encompass a more thorough framing of the role and importance of shareholder voting rights.

Fisch, Jill E. and Davidoff Solomon, Steven, The Problem of Sunsets (December 17, 2018). Boston University Law Review, 2019, Forthcoming; U of Penn, Inst for Law & Econ Research Paper No. 19-04. Available at SSRN: https://ssrn.com/abstract=3305319

12/31/2018

Bloomberg reports that there is some interest on a bipartisan basis in a Jobs 3.0 bill that would include provisions:

...intended to help companies bring in more capital through initial public offerings and certain investors.

The legislation, for example, would enlarge the group of “accredited investors” who can take part in some unregistered securities offerings, ease startup fundraising involving “angel investors,” and allow all corporations — not just emerging-growth companies — greater freedom to talk to investors and “test the waters” about their potential IPOs.

But there's some stuff missing (granted some of these would be more controversial political):

Securities fraud reform.Our expansive securities anti-fraud legal regime poses serious risks to the competitiveness of our markets. Noting that virtually all states now allow corporations to adopt charter provisions limiting director and officer liability and observing that corporate law properly consists of a set of default rules the parties generally should be free to amend, I have proposed allowing corporations to adopt provisions in their articles of incorporation to opt out of derivative litigation and/or securities class actions.

Shifting to a more flexible principles-based securities law system from the current rules-based one.

Comprehensively reviewing the governance provisions of Sarbanes-Oxley and Dodd-Frank to determine whether there are some that are imposing undue burdens.

12/16/2018

My friend and UCLAW colleague Jim Park has an interesting new article on cryptocurrency, which is a policy report for the Lowell Milken Institute:

The sudden rise of Initial Coin Offerings (ICOs) has created unprecedented challenges for the Securities & Exchange Commission (SEC). Rather than selling stock, ICOs typically raise funds by selling tokens (a type of cryptocurrency) to investors, many of whom hope to profit as the value of such tokens increases. Hundreds of companies developing projects relating to blockchain technology have sold tokens through ICOs directly to public investors without filing a registration statement with the SEC. Such sales are unlawful if such tokens fall within the ambiguous definition of a security.

This policy paper examines the SEC’s response to ICOs. It argues that selling tokens through an ICO without SEC registration requires escaping what we call the “Hinman paradox.” A token can only be widely distributed to the public if the project it is associated with is functional. But a blockchain project can only be functional if its tokens are widely distributed. Blockchain projects with simple, well-defined, and compelling objectives may be able to achieve the requisite degree of functionality and de-centralization so they can sell utility tokens without being subject to securities regulation. However, the SEC’s November 16, 2018 enforcement settlements send the message that non-functional token sales without a clear path to de-centralization will not be tolerated.

Park, James J., When Are Tokens Securities? Some Questions from the Perplexed (December 10, 2018). Lowell Milken Institute Policy Report (Dec. 2018); UCLA School of Law, Law-Econ Research Paper No. 18-13. Available at SSRN: https://ssrn.com/abstract=3298965

11/14/2018

Insider trading regulation has been primarily shaped by two theories. The first argues that unequal access to material information corrupts the integrity of securities markets. The second contends that insider trading primarily undermines the property rights of a corporation. The dominance of the market integrity and property frameworks has obscured an important reason to regulate insider trading – it can undermine the integrity of the disclosure mandated by the securities laws. Such disclosure is meant to benefit all investors and should not be exploited by a few. Insider trading is particularly problematic in a periodic disclosure system where the release of significant information is deliberately delayed so it can be analyzed and verified. This Article argues that protecting the integrity of mandatory disclosure is a compelling reason for insider trading regulation. This disclosure approach suggests clearer limits to the reach of insider trading law and enforcement than the market integrity and property theories.

Park, James J., Insider Trading and the Integrity of Mandatory Disclosure (October 1, 2018). 2018 Wisconsin Law Review (Forthcoming); UCLA School of Law, Law-Econ Research Paper No. 18-12. Available at SSRN: https://ssrn.com/abstract=3258608